Quick Summary of the Content
-You will learn about Carpetright competitors.
-There is a better company to invest in the floorcovering business.
-Five reasons why you should avoid Carpetright.
Carpetright has 571 stores (this has fallen to 561) and concessions in the UK, as well as across Holland, Belgium and the Republic of Ireland.
The company started selling all types of flooring including laminate flooring vinyl flooring, luxury vinyl tiles and (of course) carpets.
By 2008, it acquired Sleepright, a bed retailer, as it enters the bed market.
Given the stiff competition, Carpetright has launched a nationwide turnaround programme to “refresh” old stores into new ones to attract customers.
That plan is work-in-progress, but profits are still struggling.
I wonder why?
The Floorcovering market and beds market
The UK market for floorcovering is £2bn and shared among 4,000 businesses. Carpetright is the market leader with 20% market share.
For beds, the market size is £3.2bn and Carpetright have low market penetration.
Did you know that the founder’s son has launched his own carpet company called Tapi, (a French word for carpet)?
Tapi was launched in 2015 and plans to open 50 stores per year until 2018 taking the total to 200.
In their 2016 annual report, Tapi saw sales rose to 9.5-fold to £30m but is operating an net loss of £10m. The growth is supported by issuing shares as capex amounts to £10m per annum.
If Tapi opened another 50 stores in 2017, then sales are likely to grow to £50m. And given that will put further pressure on Carpetright.
For comparison to capex spending, Carpetright averages £19m in the past 20 years. And this makes Tapi a direct competitor given their growth model.
Carpetright’s Interim results is a story of two-half.
One is rising LFL and the other is falling profits.
It tells me Carpetright is sacrificing profit margins for volume, this is supported by rising sales of £6, while net store closure rose to 10 or 2% of total stores.
On an underlying basis, EPS has fallen to 2.2 pence vs. 5.6 pence.
Despite the facts that store occupancy costs fell 1% to £56.7m (less than 2%), it means operating expenses are partly to blame for poor margins, despite a cutback in marketing costs by 2.6% to £18.7m vs. £19.2m.
The balance sheet is looking vulnerable again with total borrowing rising to £32.7m vs. £13.4m, last year. An increase of £19.3m, or 8% of group sales.
Net debt grew to £22.8m, the highest level since 2012. And it looks like it will continue to increase as refurbishing stores continue.
In past Carpetright has seen net debts of £60m to £70m, but times are different and higher net debt would be averse to shareholders’ value going forward, unless it returns to profitability fast.
Historical Annual Results assessments
On an annual basis, Carpetright has seen zero sales growth, as turnover is struck between £450m-£500m for the past 14 years.
The cause of falling profits
Meanwhile, profit is a tale of two periods.
Take their pre-tax profit numbers.
The period between 1998 and 2008 saw average profit turning in £51.5m.
But, after the financial crisis that profit average £7.45m, a decrease of 85% (much like the company’s share price).
One reason for the drop in profitability is the slow recovery of housing transactions. In “pre-financial crisis”, people were moving homes by 150,000 times per month.
Housing transaction has plummeted to as low as 40,000 per month, before recovering to 110,0000. But recovery has again fallen as transactions are down 10%.
Be wary of Goodwill
Carpetright has £54m of goodwill on their balance sheet. And accounting policies suggest that Goodwill is impaired if the carrying amount exceeds the recoverable amount.
Based on Carpetright calculation of recoverable amount, which is the present value of future cash flows expected to be derived from an asset.
Their UK operation sees recoverable amounts exceeding carrying value by £516.8m and the European operating exceeds this by £97.7m.
So, Carpetright is saying they can “theoretically” generate this level of excess cash from existing assets when the market is placing a value less than £130m or an enterprise value of £155m.
Another way of twisting management words is: “I believe Carpetright valuation is around £600m, before total liabilities (£180m).”
This is based on a “five-year period” and means average cash flow should be £80m-£90m per year.
Declining Cash flow generation
And speaking of cash flow. Last year, Carpetright made £5.5m in net cash flow and interim’s cash flow is ZERO, compared to last year £5.4m.
In fact, cash flow has never exceeded £80m ever for anyone one particular year.
Let’s take a step back and say:
If market leader Carpetright is struggling to find consistency in profitability, then should you avoid the sector altogether?
Why not distribute floorcovering products?
Why create or refresh your floorcovering design, when it is more profitable to be a distributor of floorcovering.
That company is Headlam PLC and is Europe biggest floorcovering distributor with operating profit of £39m on £694m turnover.
Maybe Headlam is the one scooping up all the profits from all their clients. We will never know.
It has small amounts of debt and generates £30m in free cash flow per annum (allowing it to pay dividends).
Market Capitalisation total £445m with a PER of 14 times.
Why Bring Headlam into analysing Carpetright?
The floorcovering business isn’t exciting to investors. But if you want exposure to the housing transactions market, then your first stock to buy is Headlam.
Simply because Headlam has recovered from the financial crisis as the stock price grew from £1.60 to £5, while Carpetright has lost half its value.
So, why wait for a recovery in floorcovering like Carpetright when Headlam has an advantage in distributing the product.
At £122m, it looks cheap, until you realised the probability of making net operating cash flow looks weaker by the year.
Despite sales of £450m, the market is valuing each pound of sale at 25 pence. That looks cheap.
Carpetright needs to focus on profitability and close down unprofitable stores more frequently, much like WH Smiths.
Final Thoughts: Carpetright
I was optimistic about Carpetright at one point in time, but have changed my mind due to these factors:
–Management isn’t addressing and acknowledging the problems effectively; – although they are addressing refurbishing new stores to look brighter. There is no mentioned of designing new floorcovering or addressing the continuous decline in profit margins.
–Competition from the founder’s son; – that is like a kick in the backside to Carpetright because of the ambition from their son to open 200 stores by 2018.
That could potentially mean sales of £80m for Tapi and a lost revenue stream for Carpetright. Margins are likely to deteriorate further.
A bit discounters Lidl and Aldi stealing market share from the big four!
–Rising debt; – Although some would argue that Carpetright will pay less interest it doesn’t reflect the growth of debt isn’t reflecting higher cash profit for the business.
–Despite the market value collapsing it reflects the fundamentals of the business; – this is despite Carpetright’s management seeing the company producing present future cash flow exceeding £600m for the next five years.
–Risk of asset writedown; – a goodwill write-down is highly-likely despite what management is forecasting. And that is weighing on investors’ minds because I don’t see the company contributing much to the cause.
I advise shareholders to avoid Carpetright as risks are too high.
If I have to make a share price forecast, it would be £1.20 – £1.40 for the next 12 months. Don’t be surprised, if this goes lower than that.
CALL TO ACTION
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The above analysis is based on my opinion and nobody else. It does not constitute professional investment advice. Data is correct on at the time of availability. I don’t hold the company’s shares unless stated.